A Slowing U.S. Economic Recovery Faces Strong Headwinds in 2011

[Editor's Note: This is the latest installment in Money Morning's "Quarterly Outlook" series which has covered such topics as the housing market, silver, and technology. Make sure to watch for upcoming outlooks on the hottest emerging markets and what's ahead for U.S. stocks.]

Your email address will not be published. Required fields are marked *

Comment

Some HTML is OK

Sign me up for the Money Morning newsletter

Name *

Email *

Website

+ 5 = 8

The U.S. economic recovery has been heading upward, but high unemployment and rising energy prices will weigh heavily on consumers and slow U.S. growth.

Many economists don't think the U.S. economy will maintain the 3.1% growth rate it established in 2010's fourth quarter. The International Monetary Fund (IMF) says that while global growth this year will continue at a rate of 4.8%, advanced regions like the United States will grow at a slower rate than emerging economies.

The IMF lowered its 2011 U.S. outlook to 2.8% from 3%, citing a weak real estate market and a high jobless rate as the biggest factors.

Continued recovery will depend on how well the U.S. economy copes with these headwinds. It also depends on how much inflation takes hold and how much liquidity the U.S. Federal Reserve pumps into the economy.

"My view is that the gloom about the first quarter GDP currently is overdone, and I expect a 3% plus figure when that's announced April 29," said Money MorningContributing Editor Martin Hutchinson. "However, I expect that to be the best quarter of the recovery and expect GDP growth to be lower in the second and third quarters and possibly mildly negative in the fourth. Whether the fourth quarter minus is a blip or a new recession, I'm not sure."

Slowing Signs of Improvement

Manufacturing data and retail sales results show that while the U.S. economic recovery continues, its pace has slowed.

The Institute of Supply Management reported the U.S. manufacturing sector has expanded for 20 straight months, although growth rates are more modest than they were a year ago. Analysts expect manufacturers to spend money on mergers and acquisitions this year to try and kick-start the next stage of growth.

Retail sales increased for the ninth consecutive month in March, but only rose 0.4% after a 1.1% jump in February. The 0.4% gain was the smallest in the nine-month streak, and below economists' expectations of 0.5%.

"The apparent retreat of consumers in the face of higher prices illustrates that the household sector is in no fit shape to take the overall economic recovery to a higher level," Paul Dales, senior U.S. economist at Capital Economics, told The Financial Times.

Higher oil prices also weakened U.S. consumer confidence, which fell to a three-month low in March. The Confidence Board's measure of consumer sentiment fell to a reading of 63.4 from 72 in February.

"Consumers' inflation expectations rose significantly in March and their income expectations soured, a combination that will likely impact spending decisions," Lynn Franco, director of the Conference Board's consumer research center, told Bloomberg News.

Consumer spending accounts for 70% of U.S. economic activity, so strong retail sales numbers are needed to support an economic recovery. But higher prices and disappointing incomes will keep consumer spending from soaring to new highs.

The Heavy Unemployment Burden

Unemployment in March fell to 8.8%, a two-year low, but is still moving at a disappointing pace.

The economy added 216,000 jobs in March, but federal and state governments are still laying off their workers. Additionally, many of the new jobs are in government-subsidized services or temporary services – not the more sustainable permanent, non-government-subsidized positions.

The labor market shed 8.5 million jobs in 2008 and 2009, and has added just under 1.5 million since then. To lower the unemployment rate to a more manageable 6% over the next three years, at least 360,000 jobs have to be added each month.

About one-third of the decline in the unemployment rate since October 2009 is due to those who dropped out of the workforce and stopped job hunting. About half of the unemployed have been jobless for six months or more, and many more are considered underemployed.

The Organization for Economic Development (OECD) said in a report Wednesday that the "unusually high share of long-term unemployment" is a "striking feature" of the U.S. unemployment situation.

The stubbornly high unemployment rate also is limiting the number of eligible homebuyers and keeping a lid on the housing market recovery. A weak housing market suppresses construction hiring and stifles spending on home furnishings, appliances and home improvements.

The unemployment rate could improve if cash-rich U.S. companies start using their healthy balance sheets to invest in hiring. Since the credit crisis, U.S. companies had collected about $940 billion in cash by the end of the first quarter. But a recent report by Bank of America Merrill Lynch said that inventory rebuilding, low borrowing costs and tax breaks for equipment buying are encouraging companies to spend, not hire.

"Machines have the upper hand," Neil Dutta, the economist who wrote the report, told Bloomberg News. "You see this huge pickup in capital spending, but there isn't a meaningful increase in employment; it's being grudgingly pulled along. The consumer is not going to perform the way people expect."

Pain at the Pump

Another reason consumers could turn in a lackluster performance this year is rising energy prices.

Oil prices are up about 30% in the past year. After hitting $113.46 a barrel last Friday, they hovered around $106 a barrel this week.

Strong demand in emerging markets, a weak dollar, political turmoil in the Middle East and North Africa (MENA) region, and a strong speculative sentiment will continue to push oil prices higher. In fact, oil prices could reach $150 by midsummer and $200 by the end of the year.

More expensive crude prices pushed the average U.S. price for a gallon of gasoline to $3.81 this week, up from $3.54 in March and $3.18 in February. Gas prices will likely hit $4.00 a gallon this summer.

The rapid increases are creating cost-conscious consumers who could be scared out of spending.

"Whenever we pay more for gas, dollars leave this country to pay for imported oil," Peter Morici, an economist at the University of Maryland, told NPR. "That's money that could be spent on U.S. products, and in turn, it slows demand, slows growth and slows jobs creation."

Some say the rising fuel costs could be enough to trigger the unsteady U.S. economy into another recession.

"I can't predict recessions better than anyone else," said Morici. "But I do know that rising gasoline prices in a country that imports 10 million barrels a day is very detrimental to economic growth and can seriously threaten the recovery."

Worse, if higher oil prices translate to core inflation, the U.S. consumer will have to deal with across-the-board price hikes for consumer goods, which will further rein in household spending.

The Great Inflation Debate

The consumer price index (CPI) in March rose 2.7%, the largest increase since December 2009. That increase was in no small part driven by higher food and energy prices, as the energy index jumped 15.5% and the gasoline index rose a staggering 27.5%.

The so-called "core" CPI, which excludes food and energy, rose just 1.2% in March from the year prior.

Still, it's the core CPI that the U.S. Federal Reserve uses as a basis for policy decisions.

U.S. Federal Reserve Chairman Ben S. Bernanke has maintained that U.S. inflationary concerns are overdone, and low wages will keep rising prices at bay. However, many analysts disagree with that view.

"I expect inflation to take off, in which case the Fed will need to do something severe about it, which could cause a recession," said Money Morning's Hutchinson. "However, if inflation rises only gently and interest rates are increased only slowly maybe we can avoid that."

Some of Bernanke's colleagues have started expressing more hawkish rhetoric, as well.

Federal Reserve Bank of Dallas President Richard Fisher this week said that rising oil prices were a major concern to U.S. growth.

"It is a double whammy," Fisher said. "[I]t slows down our economy" while it "adds to inflationary pressures. It adds to the volatility of the financial system."

Fisher has criticized the Fed's easy money policies and said it's time to start tightening policies.

"There is a lot of liquidity in the system," he said. "[N]o further amount of monetary accommodation would be wise."

The latest round of quantitative easing measures will expire in June, and many wonder if there will be another to follow. Fisher said the Fed likely will discuss "curtailing" accommodative policies at its next meeting on April 26.

Protection Plays

Even if the exact path of inflation and economic recovery remains uncertain, there are investments that will give investors the best protection against a rocky recovery.

Investors should consider holding about 10% of their portfolio in precious metals, for instance.

With gold hitting record highs near $1,500 an ounce, silver is a cheaper alternative with a bullish outlook.

"I like the Sprott Physical Silver Trust (NYSEArca: PSLV)," said Money Morning Contributing Editor Peter Krauth. "The silver is stored on a fully allocated basis at the Royal Canadian Mint, which is responsible for the silver in its custody (no financial institutions in the mix)."

Analysts warn that although silver is a good play for now, a change in U.S. economic policy could serve as a signal to sell.

"Of the Canadian oil plays, I most like Suncor because of its position as the most important producer of tar sands oil," said Hutchinson. "This is only modestly profitable at current oil prices, but if prices run up or a global crisis restricts supplies, Suncor can be expected to increase hugely in profitability.

The Coming Bond Market Collapse: Three Ways to Dodge the Damage
The Coming Bond Market Collapse: Three Ways to Dodge the Damage
[Editor's Note: Martin Hutchinson's prediction of a U.S. bond market collapse is the latest installment of Money Morning's "Quarterly Report" forecast series, in which we've been providing you with analyses of gold, silver, stocks, oil and other key investment sectors. For a related forecast story on the U.S. economy that also appears in today's issue, please click here.]

Gold and silver are essential "crisis insurance" for any portfolio. Here's everything you need to know about the best ways to buy bars, coins, affordable alternatives, and more. Enter your email below to get the report.

Money Morning gives you access to a team of ten market experts with more than 250 years of combined investing experience – for free. Our experts – who have appeared on FOXBusiness, CNBC, NPR, and BloombergTV – deliver daily investing tips and stock picks, provide analysis with actions to take, and answer your biggest market questions. Our goal is to help our millions of e-newsletter subscribers and Moneymorning.com visitors become smarter, more confident investors.